Can the Pacific Alliance and MERCOSUR bridge the hemispheric divide?

By Barbara Kotschwar & Nicolas Albertoni / July 30, 2015

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The two most prominent trade blocs in Latin America today are the MERCOSUR and the Pacific Alliance. The MERCOSUR is a customs union founded by Argentina, Brazil, Paraguay and Uruguay in 1991 and joined by Venezuela in 2012. The much younger Pacific Alliance trade grouping, which was first established in 2011, joins the economies of Chile, Colombia, Mexico, and Peru through a free trade agreement, as well as eliminating visa requirements for citizens in Pacific Alliance countries, joint facilities for trade promotion in outside markets and a commitment to openness. The free trade agreement went into force on July 20, 2015.

The table below shows each bloc in numbers.

Population
(millions)

GDP
(billions US$)

Per capita GDP
(average, US$)

Exports
(billions US$)

Pacific Alliance

214

2,129

9,931

425

MERCOSUR

283

3,184

10,347

558

LAC

603

5,800

8,852

1,114

Source: IMF WEO database and IMF DOTS database

MERCOSUR’s economy is larger than that of the Pacific Alliance (PA)—55 percent compared to 37 percent of the Latin America and Caribbean’s GDP, with 47 percent of the region’s population. The Pacific Alliance punches above its weight in the trade arena, however, with 50 percent of of the region’s exports—to MERCOSUR’s 37 percent. This is largely a result of different policies towards trade and investment. The PA is based on a commitment to open trade and investment policies, and the objective of the grouping is to bolster regional trade while expanding its reach into the dynamic Asian market.

At their X Summit (Editor’s note: that’s their tenth summit not the Extreme! Summit), held in Paracas, Peru on July 1-3 of this year, the Pacific Alliance reiterated its intention to converge with MERCOSUR. Chile has spearheaded the initiative since last fall, with Foreign Minister Heraldo Muñoz calling this effort a “necessity” to “bring down the invisible wall that separates [Latin American] countries on the Pacific and Atlantic.” President Bachelet has stated that this is a “historic moment” for setting the stage to unite these two blocs.

How invisible is the wall that divides these two blocs? More important, how difficult will it be to surmount?

Most economic (and political) indicators give a sense of a region deeply divided—not by bloc but by economic policy and orientation. The figure below plots limited but representative data of the openness to trade of select countries.

With the exception of Uruguay, the scores which measure policies associated with trade and investment regimes—the higher number representing a more open regime—rank countries along the horizontal axes. The graph reveals clearly that the Pacific Alliance (Chile, Mexico, Colombia, and Peru) group groups along the “open regionalist” pole and the MERCOSUR bloc (Argentina, Brazil, Paraguay, Uruguay and Venezuela) groups along the “more closed” pole.

MERCOSUR countries are also less open to trade, have significantly higher tariffs and non-tariff trade barriers, and have signed far fewer free trade agreements than their Pacific Alliance counterparts.

Given that the Latin American countries in the two blocs are so far apart from one another in trade and investment policy terms, even if it is desirable for these two poles to converge, is it possible?

Trade diplomats are calling the Pacific Alliance-MERCOSUR meetings an encuentro inteligente. In a series of posts—this our first—we will assess how intelligent this meeting of the minds is, and offer some suggestions for constructive steps that could be taken to keep the meetings from becoming yet another Latin American forum for political posturing.

The Pacific Alliance already has a pretty full roster: implementing its trade agreement, defining the role of its thirty three—as of last count—observers, and figuring out how to reach its objective of bolstering regional value chains to better integrate with the dynamic East Asian market. Amidst all these logistical and policy challenges, converging with MERCOSUR—an agenda that goes beyond trade and investment—would seem to be, quite simply, a distraction.

One reason for Chile’s interest is the trade ties that bind the two regions together. About 4 percent of the Pacific Alliance’s exports are sent to other Pacific Alliance countries but about 4.6 percent go to MERCOSUR countries. While not huge compared to other investment destinations, the Pacific Alliance and MERCOSUR are significant investors in each other’s economies. As the figure below shows, Pacific Alliance countries invest more in MERCOSUR than MERCOSUR countries do.

Sources of MERCOSUR’s FDI stock, 2013

Investors are attracted to the Pacific Alliance in large measure because it offers openness to trade and investment and economic stability. While the alliance nearly rivals MERCOSUR in market size (see the table above), promising access to this larger joint market, should the Pacific Alliance be able to foster greater integration with the MERCOSUR, could be a boon to the smaller Pacific Alliance members.

Latin American countries share a number of common challenges, some of which could be mitigated by banding together. To a greater or lesser degree, all suffer from insufficient infrastructure—both soft and hard. Bolstering regional infrastructure could go a long way to helping exporters sell their wares to the rest of the world and attract investors to the region.

On the other hand, now that President Barack Obama has secured fast track negotiating authority, the possibility of the Trans-Pacific Partnership (TPP) and the Trans-Pacific Trade and Investment Partnership (TTIP) mega-regional agreements coming into force becomes more likely. These will have consequences for participants and non-participants alike. Although the Pacific Alliance members (with the exception of Colombia) are participating in the TPP negotiations, the MERCOSUR members are notably absent.

A common regional approach to facilitating trade by lowering the costs of doing business, could be a boon to investors, both foreign and domestic. But that would require MERCOSUR countries to make some policy changes—lowering their protection and setting more business-friendly policies. Who knows? Perhaps an unlikely Pacific Alliance-MERCOSUR convergence can eventually give rise to greater Latin American participation in global value chains. One of those areas is the region’s endemic mismatch between skills and global economic demands at the same time that across the region youth unemployment is nearing worrying levels. The Pacific Alliance is taking constructive steps to allow greater labor mobility. In this vein, expanding job opportunities to greater markets via an agreement with MERCOSUR could be a win-win solution.

There are other areas as well. Common challenges regarding energy production and usage and climate change demand regional, if not international solutions. Could the idea of cross-bloc convergence efforts provide a springboard to further action in some of these critical areas?

In subsequent posts we aim to explore potential for cooperation in areas such as trade facilitation, energy, climate mitigation and education and to look at the region’s role in global value chains. We will follow this with recommendations for Pacific Alliance-MERCOSUR cooperation (or not).

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